The coalition’s plans to cut public sector pensions have already sparked strikes and protests across the country; more are likely to follow. At heart, however, this is not just a row about pensions. The pension changes come together with hundreds of thousands of job losses and a two-year pay freeze as the government tries to reduce both short and long-term spending. All this shines a light on the widening gap between the public and private sectors; a gap which has increasingly made the two parts of the economy seem almost foreign to each other.
David Cameron’s initial explanation for the pension reforms was that the current system is “unaffordable.” But it is difficult to base an argument against future spending purely on assertions about whether or not the country can afford them. If the government wants to protect pensions, it nearly always has options: it can tax or spend more, or spend on different things.
Public sector pensions are expensive, however. Ex-public servants received £32bn in pensions in 2008-09: almost 2 per cent of national income. This is nearly two thirds as much as the universal basic state pension, which is paid to five times as many people.
But as a proportion of national income the cost of these pensions appears to have peaked. A gradual fall towards 1.4 per cent of GDP is forecast by 2050. This partly reflects changes made by the last government, which increased the pension age from 60 to 65 for new entrants into the main schemes. The coalition has already banked a further fall in cost by changing the way pension payments are to be linked to inflation.
Rather than judging the reform proposals on the basis of “affordability,” it is more useful to compare them to the overall pay levels and structures of reward in the private sector. How do they measure up?
Despite changes already implemented, there is no question that the biggest advantage public sector employees still enjoy over the private sector is in the generosity of their pensions. About 85 per cent of public employees are members of a “defined benefit” pension scheme: where pension rights are defined as a proportion of some measure of salary and years in the job. In the private sector only around one in ten workers has access to such a scheme, and that proportion is falling rapidly (see the chart above). A further quarter of private sector workers have an employer-sponsored “defined contribution” scheme—that is, a scheme where pension rights depend entirely on the performance of investments. These schemes typically involve much lower employer contributions than traditional defined benefit schemes, and individual employees must also take on all the risk.
Up to a point, there are good reasons for these differences. The state can take on risks, for example over longevity, that private companies cannot do so easily. This means it can offer pensions the private sector would find too expensive to guarantee. At root, that is why coverage of private sector defined benefit schemes has collapsed and why they need not collapse in the public sector. Indeed, nobody—least of all the government—says they should.
But thanks to rising life expectancy, the value—and therefore cost—of these public pensions has grown rapidly over the last two decades. The normal pension age of 60 for most public employees looks increasingly out of line with the state pension age, which will climb to 66 and beyond. It is also far out of line with the private sector.
Defenders of generous public sector pensions often argue that they are compensation for lower salaries. But in fact public sector salaries are not, on average, lower than those in the private sector. Because public sector workers are much more likely to be graduates than those in the private sector—think of all those nurses, doctors and teachers—average earnings are about 25 per cent higher. That raw difference in earnings means little. But IFS research suggests that when you carefully control for differences in education, age and experience, the public sector still enjoys a wage premium over the private sector, on average of 7 per cent. One effect of the two-year wage freeze in the public sector will be to close much of that gap. Yet once you take account of pensions, public sector workers are still—on average—significantly better rewarded than their equivalents in the private sector.
Of course, the advantages are uneven. For a start, the distribution of pay is more compressed in the public sector: the highest flyers do less well and the lowest flyers better than in the private sector. Wages also vary less by region in the public than in the private sector. Nurses and teachers are very well paid by the standards of labour markets in Wales and the north of England. They are not well paid in London. Job security no longer looks assured in the way it perhaps did in the past, although redundancy terms remain very generous.
That said, the typical public sector employee has a generous final salary pension; is a union member; is on a centrally set and nationally negotiated wage; and has a salary which varies little according to where he or she works. This is not how the private sector works—and if the government wants to address this difference it must rethink the whole package it offers its employees.
It must consider not only pensions, but how pay levels are determined. Are the pay review bodies, situated in the wonderfully-named Office of Manpower Economics, still fit for purpose? The lack of differentiation between wages in London, the southeast and the rest of the country also needs to be addressed. Carol Propper and colleagues at Imperial College have shown, for instance, how the relatively poor pay of nurses in London has a negative effect on health outcomes—such as increasing mortality rates in hospitals. Relatively high public sector pay in other parts of the country can also distort local labour markets.
The government must also rethink the way in which individuals are managed. Large increases in NHS pay over the last decade did not buy much in the way of employee engagement. Surveys show that many public sector employees feel they have lost a sense of autonomy and control over their working lives. It is at least possible that the move away from centrally set targets, and the coalition’s ambition to foster localism, payment by results and institutional autonomy could all help with this.
Public sector workers are not uniquely hard done by in terms of their pay. If anything, the reverse is true. The proposed pension changes for teachers, nurses, civil servants and other public sector workers are much less dramatic than many in the private sector over the last decade. Public sector pension provision will remain much more generous than in the private sector. Given the capacity of government to absorb risk, this may be quite appropriate. But the government needs an overall view of the deal it wants to strike with its own workforce. As well as pension reform, it must address management practices and pay—and think harder about how it can support pensions in the private sector too.